Builder financing may be problematic

Q. I purchased a home from builder XYZ for $320,000, and have a $10,666 Realtor rebate coming back to me. (Two-thirds of 5 percent of $320,000). The builder had me sign a paper that says the Realtor rebate can only be used to pay settlement costs. In addition, if I use XYZ's lender, the lender will pay $5,000 toward my settlement costs.

I can't imagine that my settlement costs will add to the $15,666 credit that I have. What happens to the excess? Will the builder take it off the purchase price?

A. The rebate of the Realtor's commission can only be used as a credit against closing costs. If the rebate is not fully needed for that purpose, the Realtor will keep it - it will not be taken off the purchase price.

Why is the builder willing to charge you $320,000 and pay $10,000 of your costs, but is not willing to reduce the price to $310,000? While they cost the builder the same amount on your transaction, they have different implications for other transactions.

By defining the price reduction as a rebate, the builder retains flexibility to adjust prices on a case-by-case basis, as circumstances dictate. These circumstances include differences between individual buyers - some must be persuaded to buy, while others don't. It also includes possible changes in the market over time. If demand picks up and sales increase, the rebate may no longer be necessary to stimulate sales.

If the lender reduced your price to $310,000 rather than offering the rebate, he would lose this flexibility. All the houses in the same price bracket of his subdivision would have to be reduced to $310,000. In part, this is because potential buyers would become aware that units were being sold for $310,000.

In addition, if your house was sold for $310,000, appraisals of houses in the same price bracket probably will come back no higher than $310,000. Appraised values are based on the most recent prices of comparable properties, and in a subdivision, the comparable properties are right next door. A builder would have great difficulty selling a house for $320,000 that has been appraised at $310,000.

You should be able to use the entire rebate. In addition to paying for the various services associated with the transaction, such as title insurance, you can use the rebate to fund your tax and insurance escrow account, which can be sizable. (You can estimate the required escrow using the procedure described in How Do I Figure Escrows?, on my website).

If you have excess rebate after funding your escrow account, you can use it to reduce your interest rate by paying points. But this raises the second complication in your dealing with the lender, which is the offer of a second rebate if you agree to use the builder's lender.

Builders cannot require buyers to take a mortgage from the builder's in-house lender, but they are allowed to offer an inducement to do so. The inducement in your case is the offer of an additional $5,000 rebate. But unless you know the full price from which the rebate is deducted, and compare it to prices available elsewhere, this offer is meaningless.

To illustrate, I assumed you would finance your purchase with a 30-year fixed-rate mortgage for $256,000, and on Feb. 24 I shopped this mortgage among the lenders who compete for loans on my website. The price quotes covered an interest rate range from 3.25 percent, which requires the borrower to pay $22,000 in points, to 5.25 percent, which provides $14,000 to the borrower as a rebate.

The builder's lender is offering you a $5,000 rebate but has not specified the interest rate. Since a rate of 4.625 percent commands a rebate of $6,100 in the market, if offered by the builder's lender, that rate would be $1,100 above the market.

In a similar fashion, 4.5 percent would be $200 above the market, 4.375 percent would be $2,400 below the market, 4.25 percent would be $4,300 below the market, and 4.125 percent would be $6,300 below the market. If these were the actual numbers in your case, you should receive a rate of 4.25 percent, and certainly no higher than 4.375 percent.

If you accept a mortgage from the builder's lender, you would have total rebates of $15,666, which could be more than you need to pay all settlement costs including the funding of your escrow account. The excess should not be left on the table because you can use it to reduce the interest rate.

Assume the rate offered you with the $5,000 rebate is 4.25 percent. Based on market quotes, you should be able to "buy down" the rate to 4 percent by giving up the rebate. But this kind of arrangement has to be worked out beforehand. If they won't allow you to buy down the rate, their offer of a rebate is bogus.

• Contact Jack Guttentag via his website at mtgprofessor.com.

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